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The Alphabet Soup of Limited Liability Entities

Choosing a business entity requires sifting through various combinations of letters: L.L.C’s, L.P.'s, L.L.L.P.’s, Co.’s and Inc.’s. The oldest of all these entities is the corporation.

With a corporation, the shareholders have limited liability exposure. Generally, their personal assets cannot be reached if the corporation is sued or has a creditor. The corporation must represent itself as a corporation by using the designation of something like “Inc.” or “Co.” or “Ltd.”

Since the corporation has a double layer of tax (one at the corporate level and one at the income level for the shareholders), the tax law changed to allow an “S-corporation.” The "S-corporation" is a tax designation which allows the corporation to be taxed as a “pass through" entity. That is, there is no tax at the corporate level. Instead, the income passes through the corporation and the tax is assessed against the income of the shareholder. The "S-corporation" tax designation can now be applied to LLCs.

Partnerships are “pass through" entities with the taxes being assessed against the partners’ income only. A creditor of the partnership could reach the partners’ personal assets, unless the partnership is registered as a limited partnership, using "LP" in its name and then liability protection is given to the limited partners. If the partnership is registered as a limited liability limited partnership or a limited liability partnership and uses "LLLP" or "LLP" in its name, then the general partners can also be protected from the partnership's creditors.

Choosing an entity depends on a variety of factors, including size, type of business and tax preferences. If you are just one person in business providing services, then you likely want to have an L.L.C. or a corporation. A partnership still requires at least two parties; i.e., a party being a person, trust or business entity.

If you are going to have a lot of employees and/or sell a lot of "widgets," then a corporation provides better tax benefits and more retirement benefit options. If you are not going to be really large, but your company will bring in more income than what would be a reasonable salary for each of the owners, then an S-corporation may be preferable. Again, the "S-corporation" designation is a tax designation and can be applied to a corporation or to an LLC.

With an S-Corporation the company can pay the shareholder who works for the company a reasonable salary and the remainder can be distributed as dividends. Taxes are saved because employment taxes are paid on the salary not the dividends.

If you are a professional, including a real estate broker, then you need to have either a P.C. (professional corporation) or a P.L.L.C. (professional limited liability company).

If you want to operate a business with younger family members and give them ownership interests, then an L.L.L.P. or an L.L.C. would be used. The gift of the ownership interest has a discounted tax value which limits the gift taxes that are due.

Partnerships are registered with the Office of the Arizona Secretary of State while corporations and L.L.C.’s are registered with the Arizona Corporation Commission. The Arizona Secretary of State requires annual reports for all partnerships that have limited liability (L.L.L.P.’s or L.L.P.’s).

The Arizona Corporation Commission does not require L.L.C.’s to file annual reports, but corporations are required to file annual reports and keep annual minutes of the Board of Directors and the Shareholders for three years.

These are just highlights of the considerations for choosing a limited liability business entity. Further, every business should have liability insurance to protect against the expense of lawsuits as well as potential judgments.